Opinions differ on ILS secondary market trading activity in H1 2017

The record-breaking volume of catastrophe bond and insurance-linked securities (ILS) issuance in the first-half of 2017 has driven differing opinions on the trading activity in the secondary marketplace, according to recent ILS reports from Aon Securities and Swiss Re Capital Markets.

The ILS and capital markets arm of reinsurance giant Swiss Re has discussed the record-levels of catastrophe bond and ILS issuance so far in 2017, which took the market to new heights in terms of the number of deals and the volume of deal issuance.

Swiss Re expects the ILS space to maintain its current, impressive growth trend, and notes in its August 2017 ILS market update how the performance of the space in the opening six months of the year impacted trading in the secondary market.

“Trading in H1 2017 was slightly lighter than in previous years,” explains Swiss Re, adding that the majority of activity took place in January and February and concerned off-risk bonds.

Typically, and as seen in other years, off-risk bonds are used as a cash-management mechanism and trade to a discount margin in the mid/high 100s bps, says Swiss Re. However, in 2017 some potential buyers were “content” to wait for the expected pipeline of new issuance, which saw some off-risk bonds trade in the low 200s, says Swiss Re.

During the second-quarter of 2017, which experienced more cat bond and ILS issuance than any other quarter on record, there was some light trading in the secondary market, but activity was “muted”, says Swiss Re, with most investors seemingly putting all their resources to the record-level of new issuance.

“There was significant demand for a wide variety of bonds throughout 1Q, as many investors were flush with cash, both from fresh capital raises and the large volume of maturities. However, supply was fairly light as potential sellers were waiting for the rumors of the heavy-issuance pipelines to materialize,” explains Swiss Re.

The “muted” Q2 trading activity reported by Swiss Re Capital Markets is in contrast to that witnessed by Aon Securities, which, in its Q2 2017 ILS market report highlights that secondary trading in Q2 actually increased, following four consecutive months of declining activity.

Aon Securities, the capital markets division of insurance and reinsurance broker, Aon, notes that according to FINRA’s Trading Reporting and Compliance Engine (TRACE), 231 trades, amounting to $236.4 million took place during Q2, up 6% on the same period in 2016, in terms of the number of trades.

However, while the number of trades increased, in terms of dollar volume, the $236.4 million of trades is actually a decline of 4% when compared with the second-quarter of 2016, which, Aon Securities attributes to several reasons.

This includes “new, smaller funds that entered the space during the quarter as well as established funds rebalancing their portfolios upon receiving allocations from the numerous primary issuances available,” says Aon Securities.

The increase in trades in the second-quarter is even more pronounced when compared with the first-quarter of 2017, with TRACE reported trading activity revealing the number of trades actually increased by 32% in Q2. While the dollar volume of trades also increased by 14% in the period, when compared with the first-quarter of 2017.

Furthermore, the high level of new issuance the market witnessed in Q2 had an impact on the usual slowdown in trading that happens at the start of the hurricane season. Aon Securities notes that the slowdown simply didn’t occur this year, with trading in the month of June being more active than in 2016.

The differing views on secondary trading in the ILS market by the reinsurer and broker is interesting, with one noting “muted” activity as a result of record-breaking new issuance, while the other witnessed increased activity, also driven by the record level of primary issuance.

The difference could well come down to one company seeing more or less trading activity across their desks in the period, when compared with the other.

But despite the differences, scheduled ILS and cat bond maturities during the second-half of 2017 are fairly light, so it will be interesting to see if the strong primary issuance trend (highlighted by Aon here) of Q2 persists and what impact this might have on the secondary market.

Typically, as issuance increases greater secondary market liquidity is the result, which helps investors in the space realise and take advantage of the full benefits of the growing asset class.